Undervalued Energy Titan Yields 5.6% With A 6.6% Special Dividend

When most US investors think about the energy majors and oil companies in particular, the first name that comes to mind is Exxon Mobil (NYSE:XOM), followed by Chevron (NYSE:CVX). And while Chevron and BP are certainly solid and safe investments, investors are missing out if they fail to consider the appeal of foreign oil majors. Many foreign oil majors are trading at attractive valuations and/or superior yields compared with US peers due to investor concerns about the global economy and outflows of cash from foreign markets.

The chart below illustrates this:

Firm

Ticker

Mkt Cap

P/E

Yield

Consensus Fair Value

Recent Price

Exxon Mobil

XOM

403B

9.2

2.80%

$89.90

$90.40

Chevron

CVX

230B

9.0

3.40%

$114.00

$119.00

BP

BP

133B

6.0

5.00%

$46.40

$41.80

Shell

RDS.A

203B

7.8

5.60%

$69.90

$63.90

ENI

E

73B

26.1

6.80%

$40.80

$41.10

Petrobras

PBR

90B

9.3

9.00%

$16.90

$13.30

Total

TOT

108B

9.9

6.25%

$48.80

$48.68

Now compared with the rest of the stock market, the oil majors seem very inexpensive, at least based on their P/E ratios. Yet of these firms, one in particular stands out to me - Royal Dutch Shell (NYSE:RDS.A). Shell is trading at a lower P/E ratio than any of the other foreign oil majors except for BP (NYSE:BP) which is embroiled in the ongoing Gulf of Mexico/Deep Water morass. And while few risk-averse investors would want to get involved with BP given these legal troubles, Shell faces no such obvious hurdles.

Similarly, looking at the consensus fair value estimates (based on mean fair values as calculated by all analysts covering a given stock), Shell is one of the few trading at a significant discount to fair value. The other two that fit this criteria are BP, which again has significant issues, and Brazilian major Petrobras (NYSE:PBR) which is dealing with a government that is becoming increasingly hostile to its interests. Exxon Mobil, Chevron, and foreign firms ENI (NYSE:E) and Total (NYSE:TOT) all trade near fair value.

Finally, while Shell's dividend doesn't offer quite the same level of yield that some of the other firms offer, its yield is likely to be a lot safer, something that investors should doubly appreciate, given the prospect of rising rates over the next few years and the inconsistency in some peer firms' dividends. In fact, analysts on average expect Shell's dividend to increase by 4.7% this year.

Well, one reason is probably because investors have been concerned for a while about the company's productive reserves. Over the last eight years, Shell's reserves have declined noticeably, and the firm also holds significant market share in the liquid natural gas [LNG] market which has struggled with low prices lately. Yet both of these issues seem like they might be about to improve.

Analysts are forecasting that Shell's reserves should rise for the next four years, and with the renewed focus by Obama (see my article here) on natural gas and away from coal, LNG prices look set to rise as well. Shell's interests in the Canadian oil sands should benefit from these developments as well as it looks like the TransCanada pipeline has an improved chance of being approved by the Obama administration, which would lead to greater interest in that grade of oil. Further, Shell's downstream refinery operations should benefit from widening margins as the economy improves over time.

In fact, Shell has been doing fairly well of late generating increasing amounts of cash, and a healthy expansion in revenues as the chart below shows.

FYE

2012

2011

2010

2009

Tangible Book Value

59.71

52.65

46.43

42.82

EPS

8.48

9.94

6.56

4.09

Dividends

2.91

2.86

2.98

3.06

Payout Ratio

34%

29%

45%

75%

Price: High

74.52

77.97

68.55

63.75

Price: Low

60.62

57.97

49.16

38.26

P/E: High

9

8

10

16

P/E: Low

7

6

7

9

Revenue

481B

470B

368B

278B

Net Income

26.8B

31.2B

20.5B

12.5B

Cash

18.6B

11.3B

13.4B

9.8B

Current Ratio

1.2

1.2

1.1

1.1

ROE

15.00%

19.60%

14.40%

9.50%

It's clear that with revenues, EPS, and cash all expanding, Shell should be reaching new highs. The firm has plenty of room to expand its dividend, given the fact that it is only paying out about a third of earnings, and its return on equity would be the envy of most companies out there. Yet, the stock is trading near its 52-week low.

(click to enlarge)

The best explanation I can think of for this apparent disconnect between Shell's value and its price, is that the company has been beaten down by the recent talk of Fed tapering and investors have fled the stock as they have fled so many other dividend payers despite the insanity this represents (see my article here). This decline in Shell's price has undoubtedly caused concern among many investors in the stock, but for long term holders, the company's dividend should offer some consolation. Unfortunately, it is possible the stock will continue to face pressure going forward if the Fed does in fact begin to taper its bond purchases. For that reason, investors may want to consider taking advantage of a call options to give themselves a "special dividend" on the stock.

While there are a variety of call options that could be profitably used by holders of Shell stock (see my article here for more details), I think the January $65 calls may be particularly attractive to sell. Given recent prices in Shell and the call options, these 6 month options could be sold for 3-3.5% in call premium (plus roughly $1 of upside assuming the calls get exercised). This gives investors the equivalent of about a 6.6% annualized "special dividend" and is a good way to take advantage of the overhang that Fed Tapering is likely to leave on the stock going forward.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in RDS.A over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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